Cash Management: Pay It Now or Pay It (A Lot More) Later

By John Supan

Best (and Worst) Practices for Cash Management When Cash Resources Are Scarce

Entrepreneurial technology businesses are often in need of critical cash to continue operating while seeking additional debt or equity financing for growth. Some simple but very short-term ways to stretch cash include delaying vendor payments and accelerating customer collections or, at the very least, holding customers strictly to their invoice payment terms. But these efforts need to be cautiously practiced lest your vendors begin to consider you a credit risk or your customers begin to seek alternative suppliers if they believe your business (and continuation of your goods or services) are at risk. Unfortunately, once payables are aged to the max and customers are pushed to annoyance, these savings-oriented strategies become a one-time event that often do not offer incremental opportunity on the cash flow front.

A continued need for cash necessarily correlates to a need for more creative solutions to preserve it. During such times, less disciplined business operators are often tempted to defer certain cash expenditures not essential to their core purpose. Cash is reserved solely for “keeping the operational lights on” such as payroll for key employees, essential consultants, facility lease payments, and critical vendors. This cash management approach is completely fine if it is short lived and a near-term infusion of cash is imminent. However, deferrals of non-critical cash expenditures may work so well in practice that these may become too tempting to abandon later. After all, we’re saving so much cash now, what could go wrong if we continue to rein in expenditures?

Here’s what can go wrong with these types of restrictive cash management strategies:       

• Financial Reporting: Sloppy financial reporting causes the board to lose confidence in the reliability and accuracy of the reports provided.
• Client Service: With discretionary expenditures cut, customer service starts to lag and has the potential to damage important relationships needed for future revenues.
• Work Force Incentives: Employee stock option distributions are ignored, thus disincentivizing your work force.
• Tax Liabilities: While Federal and state income tax returns are usually filed on time (or under allowable extensions), state sales and use tax returns are often not timely filed and these obligations accumulate along with interest and penalties. Time must be allocated for negotiating with tax authorities to “come clean” later, often requiring the hiring of expensive external SALT (state and local tax) experts.
• Foreign Entity Reporting: Statutory compliance for foreign entities are ignored. Catching up on these is expensive and “good standing” is lost along with future credibility.
• Capitalization Tables: The company’s cap table isn’t kept up to date, on which investors and new investor prospects depend.
• Audit Compliance: Independent audit services are terminated – certain periods become “un-auditable” because inventories weren’t observed or other critical account reconciliations were left undone. Audit team members rotate off your account, losing key knowledge among the audit team. New accounting standards are ignored or improperly implemented; e.g., revenue recognition, which can result in financial restatements.

Longer-term cash restrictions and conservation policies risk a host of detrimental consequences including:

• Recruiting new employees becomes more difficult as well as finding qualified executives and board members.
• Employees (especially key hires) lose confidence and leave for other opportunities. The “A” players will leave first and you’re stuck trying to build your business with the “B” team.
• Critical institutional knowledge walks out the door with departing employees and consultants and all those cash-saving, deferred activities become a nightmarish process to understand, unravel, reconstruct, and solve by uninitiated staff at a later date.

Even if a company finds new sources of cash via acquisitions, additional sources of credit and/or fundraising, longer term effects of this restrictive approach to cash management continue:

• New cash that is invested is at a diminished valuation for the enterprise, thus diluting existing investors.
• M&A possibilities likely disappear or are at the very least delayed since your ability to provide clean records to populate a data room are impossible to provide.
• Those employees that you have been fortunate enough to retain may now have “under water” strike prices on their option grants disillusioning them about their future with the company.
• Re-hiring key employees and consultants takes time (identifying, recruiting, and negotiating). Onboarding them also takes time as well as getting them up the learning curve so that they adequately understand your business.
• Corrective filings and reporting activities are expensive and take considerable time while you engage in “forensic” analyses which require recreating the past. This robs you of dedicating your efforts to building your business and instead necessarily focuses your team on recreating the past, a thankless exercise.

So how does a growing company fund their need for additional cash without restricting their cash-using practices too narrowly and also meet important organizational objectives for investor ROI, client service, employee relations, risk management, etc.?

Here are 5 recommendations for better cash management policies and practices for both the short and longer term:

1. Talk to your board and investors early on – focus on fewer, value-added milestones to demonstrate long term viability of the business. Keep a detailed list of lower priority initiatives to take advantage of later on so that you can demonstrate to stakeholders that these important, value-enhancing actions are already identified to be pursued downstream when additional cash becomes available.

2. Recreate your spending plan (budget) to conserve cash yet reasonably preserve key business processes and functions. Enlist the support of your management team and advise all employees of your actions. With a reasonable plan, you’d be surprised how you can inspire both confidence and esprit de corps among employees. They see their involvement as a sign of trust to become part of the solution instead of pawns in a process that they’re not worthy to participate in.
3. Talk to your bankers – if your business is growing, working capital loans are available to assist you and working capital can consume a huge amount of cash in a growing business.

4. Talk to your vendors as many will appreciate your forthcoming candor and will be interested in building a long term and lasting relationship with your business as it grows and flourishes later.

5. Most importantly, plan your cash fundraising activities well in advance of your expected cash out date. This process always takes longer than expected and for reasons often beyond your control. And having less cash on hand when negotiating puts you at a distinct disadvantage… and investors and lenders know it!

Best practices in cash management for growing enterprises dictate careful consideration of multiple objectives, balancing both cash needs and uses to properly advance your business enterprise. Abandoning or substantially deferring necessary regulatory, finance, legal, and administrative functions in the short term will cost your company substantially more in the longer term. In addition, these types of short-sighted actions can result in serious disruption to your management team and work force, an enormous delay in achieving milestones in your roadmap and, importantly, the very real prospect of lost M&A opportunities due to associated declines in shareholder value.

At FLG, we’re masters of cash management. Whether you are raising capital for growth or just fine-tuning EBITDA as a more mature enterprise, if you need advice about maximizing your cash flow – both short term and long term, we’re your solution.